Labor Productivity

Labor productivity is a key element in the explanation of how the economy works. It is especially important with regard to wages. What follows is some material about labor productivity and investment spending that is a reorganization of what is presented in your textbook. Its focus is on the connection between labor productivity and wages. Labor productivity is the value of the product or service you can produce in an hour, day, week or other unit of time. The value you can produce depends on the amount of work-product you can produce and the price at which that product can be sold.

When the product is sold, the owner keeps part of that value as profit, and part of it goes to pay for other production expenses. The worker then gets the residual as the wage. (The Marxists like to talk about this as exploitation and expropriation of the surplus. ) If you want a sustained increase in your real wage, you have to have an increase in labor productivity. However, you may not get a raise just because your labor productivity rises. Labor productivity may rise, thereby raising the value of your day’s work, but the owner can keep the increase as higher profit.

This raises two questions: How can you get to keep a part of increased labor productivity in a higher wage, and what contributes to systematic increases in labor productivity? First, your boss will want to keep you as a worker, assuming you are a good one. When the business cycle is at a point where actual GDP is near full employment and expanding, other firms will want to hire workers away from the company you work for. You get a raise to keep you where you are. The other way is to have a union that negotiates with the owner for a share of increased labor productivity.

To answer the second question, consider the following. Systematic increases in labor productivity come from investment spending. Investment spending, in the broadest sense, refers to spending that creates more capital for workers to use. The most obvious capital is new plant and equipment and new technology. If workers have better machines (a rise in the capital to labor ratio), they can produce more value per hour. The common sense of this can be seen with a simple example: How much land can you till and plant if your capital is just a stone? How much if you have a shovel?

How much if you have a shovel and a hoe? How much if you have a tractor and a plow? How about a great big tractor with four wheel drive, 8 or more wheels and huge implements to go with the tractor? The same thinking applies to service work as well. Human capital is less tangible than machines but very real. Human capital refers to skills, knowledge, analytical ability, and especially the ability to teach yourself new stuff. It is the corner stone of the modern economy. If you don’t have much human capital, the workplace will not pay you too much for your time.

Human capital comes through job training, formal and informal education, and self-education. The value of a four-year college degree comes mostly from the analytical abilities you develop and the ability to teach yourself new stuff, and you can only develop these skills by practicing, which is what studying is all about. Innovation and new technology come out of the application of human capital to the problem of ever-present scarcity. The problem with acquiring human capital is that the process is expensive, and there are real financial and risk constraints faced by individuals.

If individuals were left to pay the entire cost of training and education, there would be less of it than the economy needs because of these constraints. So in modern society, through government, assumes a large chunk of the risk through the subsidization of job training and education. TriCounty is a classic example. The taxpayers pay most of the expense of the services provided, and the taxpayers receive the benefits spread out over time because companies have a more productive labor force to draw from, a labor force with the human capital needed to pursue higher-valued work.

This is the case throughout the industrialized world. Infrastructure is the third category of capital. Infrastructure can be public or private. Communications companies are private infrastructure. Roads, bridges, and most airports are public infrastructure. Public infrastructure exists when private companies lack an incentive to provide the needed capital. The lack of incentive comes from the lack of ability to exclude non-payers from utilizing the products or service. National defense and public fire stations are examples.

When the infrastructure is private, consumers pay for the costs of producing the services in the price they pay for the services. When the infrastructure is public, consumers pay for the services with taxes and sometimes fees. If you want a sustained increase in wages, you have to have an increase in labor productivity, so you need additional capital, so you need additional investment spending, and if you want more investment spending, you need more savings. If you want more human capital and public infrastructure, you need more tax revenue. There is no way around it.